MARKET COMMENT
Abbey Shocker Is Company Specific

By David Kuo
June 10, 2002

In March we concluded that the banks in general were starting to look less attractive on valuation grounds. Now Abbey National (LSE: ANL) has dropped a bombshell on the sector with its first ever profit warning. Abbey sank some 10% this morning and many other banking shares were in the red too. Abbey said its decline in profit is largely due to underperformance in its Wholesale Banking operations. It has had to make bigger provisions to account for riskier loans that it has advanced to companies such as the troubled energy trader Enron (NYSE: ENR). In February, at the time of the bank's full-year results, it reported a provision of £95m specifically for loans made to Enron. Clearly that was not quite the end of the Enron saga and bigger provisions are now needed. The UK's sixth-biggest bank also blamed its exposure to telecom companies and lower sales of with-profit bonds.

Abbey National will be providing an update on the strategic review of its Wholesale Banking business tomorrow. Clearly the company wants to get the bad news out into the open today in order that investors can focus on the contents of its review tomorrow. However, the Wholesale Banking division represents only about a quarter of the bank's total profit. The major contributor of Abbey National's profits come from retail banking, which according to the company is still trading within the range of market expectations. The bank has said that Retail Banking, Wealth Management and the Long-Term Savings businesses would be the main driver of sustainable growth over the medium term.

This then begs the question as to why Abbey National would even want to get involved in Wholesale Banking. Of course diversification can bring substantial rewards in terms of reducing the group's overall risk to just a few sectors of the market. The move into junk bonds and other higher risk treasury services businesses is hardly in keeping with a risk reduction strategy though. Nor is the company's move away from mortgage lending in keeping with the culture of a bank whose roots have always been firmly planted in the security of home ownership. Investors should take comfort from the fact that today's warning from Abbey National looks to be company specific. It is also an indication of a failure in the execution of a corporate strategy, which Abbey will hope to put right when it announces the results of its strategic review.